With 2021 now upon us, companies, auditors and audit committees are gearing up for another annual reporting season, coming off of one of the more turbulent years in recent history, which included a significant number of regulatory developments on which we've previously reported on this blog. Summarized below are some notable developments that occurred toward the end of 2020 and are worth bearing in mind for the upcoming reporting season:
- SEC and PCAOB Leadership Transitions. In connection with the upcoming change in presidential administration, a number of senior leadership posts are changing at the SEC. Notably, Chair Clayton's final day was December 23, and Elad Roisman was designated Acting Chairman on December 28. Other recent departures include Bill Hinman, who ended his term as Director of the Division of Corporation Finance on December 4, and Stephanie Avakian, who ended her term as a Director and Co-Director of the Division of Enforcement. Steven Peikin, former Co-Director of the Division of Enforcement, left the agency in August. In December, the SEC announced that Dalia Blass, Director of the Division of Investment Management, and Robert Stebbins, General Counsel, will depart the SEC in January.
Meanwhile at the PCAOB, Megan Zietsman was sworn in as a Board member in November, filling the seat previously occupied by Jim Kaiser. Prior to her appointment, Ms. Zietsman was the PCAOB's Chief Auditor and Director of Professional Standards.
- AICPA Conference Takeaways. Like many reflecting on the impacts of the COVID-19 pandemic this year, regulators at the 2020 AICPA Conference on Current SEC and PCAOB Developments, held in December, shared a mix of reflections on the impact of the COVID-19 pandemic, significant regulatory developments, and practical guidance concerning technical accounting questions.
SEC Chief Accountant Sagar Teotia noted how investors benefitted in 2020 from the "continued flow of high-quality financial information upon which to base their investment decisions" and how such information supports the continued functioning of our capital markets. That theme permeated his remarks, which highlighted to a great extent the Office of the Chief Accountant's responses to COVID-19 during 2020.
Mr. Teotia discussed a number of cornerstone topics that will remain of critical importance during 2021, a couple of which include:
- Judgments and Estimates. Noting the challenges of making judgments and accounting estimates in an uncertain and volatile environment, Mr. Teotia reiterated that the "OCA staff has consistently not objected to well-reasoned judgments made by companies, and we will continue to apply this perspective." He also reminded companies to ensure that these judgments and estimates are disclosed in an understandable manner that is useful to investors and that the company's financial reporting is consistent with the company's specific facts and circumstances.
- Internal Control Over Financial Reporting (ICFR) and Disclosure Controls and Procedures (DCP). The SEC has long stressed the importance of maintaining solid ICFR and DCP. Both are in the spotlight as a result of COVID-19, as many companies implemented changes to their financial reporting processes to adapt to a remote work environment. Management is required to assess the effectiveness of ICFR and DCP and disclose, in the quarter in which it occurs, any changes that materially affects, or is reasonably likely to materially affect, the company's ICFR.
In addition to management's responsibility for the above items, audit committees play a critical role in these areas through their oversight of financial reporting and ICFR, as well as the company's internal and external audit process. As Mr. Teotia noted, "In these times of rapid change and increased uncertainty, the need for the oversight role that audit committees play is as critical as ever."
Mr. Teotia's discussion also summarized a number of issues resolved and positions taken by OCA during the year and included links to several resources worth keeping in mind for the year ahead, including a link to the SEC's Coronavirus (COVID-19) Response webpage. For more details on the technical accounting topics addressed at the conference, see the Appendix at the end of this post, which includes links to speeches by members of the SEC staff at the annual AICPA conference categorized by topic.
From a PCAOB perspective, members of the Board spoke at the conference and discussed several topics, including PCAOB processes to assess an audit firm's remediation of deficiencies identified in its system of quality control. Board Member J. Robert Brown posted written remarks to follow up on the topic, noting that remediation of audit quality deficiencies, including transparency around the process, is "currently undergoing transformation at the PCAOB." He described the remediation of audit quality deficiencies as requiring "a change that is relevant and responsive and appropriately designed to address the criticisms," taking into account the nature and frequency of the criticism a firm receives. The PCAOB believes added transparency around remediations would offer investors greater insight into the process and would allow audit committees to better communicate with audit firms about audit quality and the oversight of the audit client's audit process.
- Voluntary Audit Committee Reporting. Over the past several years, the number of companies providing voluntary disclosures about the audit committee's activities has steadily increased, and a recent report by the Center for Audit Quality (CAQ) and Audit Analytics confirms that increases generally continued through the 2020 proxy season, based on a review of proxy statements filed through the end of June 2020 by S&P 1500 companies.
2020 also saw some new voluntary audit committee disclosures, as some companies provided additional transparency into the board's approach to navigating the impact of the COVID-19 pandemic, including the audit committee's role in overseeing risks to ICFR, disclosure controls and procedures and the completion of the company's audit. Separately, the report noted that over 6% of companies mentioned CAMs within their audit committee disclosures, including that the audit committee discussed CAMs with the auditor.
In terms of disclosures long tracked by the CAQ and Audit Analytics, cybersecurity disclosure is the most notable area of increase for the second year in a row, with the report noting as follows with respect to S&P 500 companies:
- 39% disclosed that the audit committee is responsible for cybersecurity oversight, as compared to 34% in 2019 and 11% in 2016.
- 28% disclosed whether the board has a cybersecurity expert, as compared to 23% in 2019 and 7% in 2016.
- 27% disclosed the committees on which the cybersecurity expert serves, as compared to 22% in 2019 and 7% in 2016.
Aside from cyber, the latest data shows some modest increases and continued strong percentages in other key areas for S&P 500 companies:
- 51% discussed the criteria the committee considered when evaluating the audit firm, as compared to 50% in 2019 and 8% in 2014.
- 43% disclosed the audit committee's considerations in appointing the audit firm, as compared to 42% in 2019 and 13% in 2014.
- 84% discussed how non-audit services may impact the external auditor's independence, the same as in 2019 and an increase from 83% in 2014.
- 50% expressly stated that the audit committee is involved in the selection of the audit engagement partner, the same as in 2019 and an increase from 13% in 2014.
- 49% stated that the audit engagement partner rotates every five years, the same as in 2019 and an increase from 16% in 2014.
Disclosures for S&P 500 companies that experienced a decline include:
- 19% explained a change in fees paid to the audit firm, a decline from 23% in 2019 and 28% in 2014, which may be a function of the occurrence of transactions or other events driving the change in fees.
- 18% disclosed whether the audit committee is responsible for audit fee negotiations, a decline from 19% in 2019, though still higher than the 8% reported in 2014.
Similar to conclusions in the 2019 Transparency Barometer, the CAQ and Audit Analytics continued to observe some areas of concern and opportunities for enhanced transparency with respect to the discussion of audit fees and the connection to audit quality (4% of S&P 500 companies disclosed in 2020), how the audit committee considers auditor compensation (3% of S&P 500 companies disclosed in 2020) and disclosure of significant areas of discussion with the auditor (0% of S&P 500 companies disclosed for 2016-2020).
- Critical Audit Matters. In June 2019, the PCAOB's new critical audit matters (CAMs) disclosure requirement first went effective for audits of large accelerated filers with fiscal years ending on or after June 30, 2019. The standard is now effective for audits of all other issuers (except EGCs and a few narrow issuer categories) with respect to audits of fiscal years ending on or after December 15, 2020.
The PCAOB published an interim review of the initial implementation of the new standard. The PCAOB observed that audit firms made significant investments to implement the CAMs requirement, which contributed to a generally smooth process that, so far, has not resulted in any unintended consequences, according to the PCAOB. While the PCAOB noted that investor awareness continues to develop, some investors have reported that they find the CAMs disclosure useful.
Based on a review of 2,040 filed reports containing CAMs disclosure between June 30, 2019 and June 29, 2020, the PCAOB found an average of 1.7 CAMs communicated per report, with the total ranging from 0 to 7. In order of frequency, the four most common CAMs involved revenue recognition, goodwill, other intangible assets and business combinations. The PCAOB plans to issue an updated report in 2022 to provide any new perspectives with respect to the communication of CAMs and to offer insights into the impact on audits of smaller issuers.
- Auditor Independence Rules. Later this year, changes to auditor independence rules are scheduled to take effect. In October, the SEC adopted modernizing amendments to its auditor independence rules. Most notably, the amendments address independence violations that could result in situations involving relationships with sister companies "under common control" with the entity under audit, such as portfolio companies controlled by the same private equity firm, or companies affiliated with an investment company. In this regard, the amendments narrow the definitions of "affiliate of an audit client" and "investment company complex" to only encompass sister entities that are material to both the entity under audit and the controlling entity.
The amendments also introduce a new transition framework for assessing independence, and avoiding inadvertent independence violations, following merger or acquisition transactions. Other changes include a shortened lookback period for evaluating an auditor's independence with respect to a new IPO company and the addition of certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships. With respect to an accountant's business relationships with stockholders of an audit client, the amendments replace the reference to "substantial stockholders" with "beneficial owners (known through reasonable inquiry) of the audit client's equity securities where such beneficial owner has significant influence over the entity under audit," which is intended to clarify and simplify the analysis.
The SEC's rule amendments are scheduled to become effective June 9, 2021. To align with the amended SEC rules, the PCAOB proposed conforming amendments to its auditor independence rules in November, which remain subject to SEC review.
- Other Recent PCAOB
Developments. Racing to the finish line, the
PCAOB engaged in a relatively robust amount of year-end activity,
which included approving its 2021 budget and reaffirming its strategic
direction, rolling out a new brand and redesigned website, and issuing
a COVID-19 Spotlight for auditors, among
others. As the PCAOB noted, the "PCAOB's 2021
budget-which includes investments in personnel, processes, and
technology-will provide the Board with the resources necessary to
continue to implement its strategic plan." The
rebranding and redesigned website evidence one element of the
PCAOB's commitment to improved outreach and engagement, which
is one of the five goals included in the PCAOB's 2020-2024 Strategic Plan:
- Drive improvement in the quality of audit services through a combination of prevention, detection, deterrence, and remediation.
- Anticipate and respond to the changing environment, including emerging technologies and related risks and opportunities.
- Enhance transparency and accessibility through proactive stakeholder engagement.
- Pursue operational excellence through efficient and effective use of our resources, information, and technology.
- Develop, empower, and reward our people to achieve our shared goals.
PCAOB Chairman Duhnke commented that while many of the PCAOB's efforts in 2020 were dedicated to responding to the COVID-19 pandemic and its challenges, the PCAOB continued to execute against its strategic plan, highlighting improvements in the efficacy of the PCAOB's oversight through inspections, enforcement and standard-setting; increased focus on innovation; increased investor, audit committee and preparer engagement; and advances to optimize the PCAOB's business processes and culture.
The following table includes links to speeches by members of the SEC staff at the annual AICPA conference, categorized by the topics addressed in their remarks:
|Topic||Speaker (Area of Focus)|
|Auditor Independence||Sheena Lam (overview of recent rule amendments)|
|Consideration Received from Vendors||Kevin Cherrstrom (gross v. net cash flows presentation); Damon Romano (considerations when vendor made payments for a variety of reasons)|
|Consolidation||Jeffrey Nick (voting interest entities)|
|Critical Audit Matters||Jeffery Joseph (initial implementation review and initial impact of CAMs requirements)|
|Discontinuation of LIBOR||Jillian Pearce (evaluating whether interest rate reset features based on the Secured Overnight Financing Rate are an embedded derivative that requires separate accounting)|
|Equity Method Investments||Jeffrey Nick (evaluating "significant influence")|
|Leases||Geoff Griffin (abandonment of right-of-use assets)|
|Revenue Recognition||Kevin Cherrstrom (identification of performance obligations under software license); Geoff Griffin (principal v. agent considerations in the digital advertising industry or other industries in the technology space); Jillian Pearce (principal v. agent considerations when registrant produces and sells a commodity to consumers)|
|Variable Interest Entities||Damon Romano (primary beneficiary determination)|
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